Credit Opinion: BAWAG P.S.K.

Transcription

1 Credit Opinion: BAWAG P.S.K. Global Credit Research - 03 Oct 2013 Vienna, Austria Ratings Category Outlook Bank Deposits Bank Financial Strength Baseline Credit Assessment Adjusted Baseline Credit Assessment Senior Unsecured Senior Subordinate -Dom Curr BAWAG Capital Finance (Jersey) II Limited Outlook Pref. Stock Non-cumulative BAWAG Capital Finance (Jersey) Ltd Outlook BACKED Pref. Stock Non-cumulative Moody's Rating Stable Baa2/P-2 D (ba2) (ba2) Baa2 Ba3 Stable B2 (hyb) Stable B2 (hyb) Contacts Analyst Phone Michael Rohr/Frankfurt am Main Mathias Kuelpmann/Frankfurt am Main Carola Schuler/Frankfurt am Main Mira Carey/Frankfurt am Main Key Indicators BAWAG P.S.K. (Consolidated Financials)[1] [2]6-13 [2]12-12 [2]12-11 [2]12-10 [2]12-09 Avg. Total Assets (EUR million) 38, , , , ,225.0 [3]-1.9 Total Assets (USD million) 49, , , , ,147.2 [3]-4.3 Tangible Common Equity (EUR million) 1, , , , ,372.7 [3]7.0 Tangible Common Equity (USD million) 2, , , , ,969.5 [3]4.4 Net Interest Margin (%) [4]1.5 PPI / Average RWA (%) [5]1.6 Net Income / Average RWA (%) [5]0.8 (Market Funds - Liquid Assets) / Total Assets (%) [4]4.1 Core Deposits / Average Gross Loans (%) [4]95.9 Tier 1 Ratio (%) [5]10.5 Tangible Common Equity / RWA (%) [5]7.7 Cost / Income Ratio (%) [4]62.3 Problem Loans / Gross Loans (%) [4]4.8 Problem Loans / (Equity + Loan Loss Reserves) (%) [4]35.4 Source: Moody's

2 [1] All figures and ratios are adjusted using Moody's standard adjustments [2] Basel II; IFRS [3] Compound Annual Growth Rate based on IFRS reporting periods [4] IFRS reporting periods have been used for average calculation [5] Basel II & IFRS reporting periods have been used for average calculation Opinion SUMMARY RATING RATIONALE BAWAG P.S.K. Bank für Arbeit und Wirtschaft und Oesterreichische Postsparkasse AG's (BAWAG) Baa2/Prime- 2 long-term and short-term deposit ratings reflect BAWAG's importance in the Austrian banking market and our assessment of a very high probability of systemic support, in case of need. Under our Joint Default Analysis (JDA) methodology, this results in a three-notch uplift of the long-term senior ratings to Baa2 from BAWAG's ba2 baseline credit assessment (BCA). We assign a standalone bank financial strength rating (BFSR) of D to BAWAG, equivalent to a BCA of ba2. The rating reflects BAWAG's (1) improving but still modest financial metrics, demonstrated by the low profitability of the bank's core business segments and only gradually improving efficiency; (2) high risk concentrations; and (3) continued reliance on capital support in the form of government participation capital, which we only expect to be fully paid back in the longer term. We note BAWAG's growing exposure to peripheral euro area and higher-rated structured credit assets replacing legacy investments in the bank's structured credit book. However, the rating also reflects (1) BAWAG's well-entrenched and expanding franchise as a large retail and commercial bank in Austria; and (2) its satisfactory liquidity profile benefitting from a stable and granular deposit base. 'Grandfathered' debt obligations, guaranteed by the Republic of Austria (Aaa, negative) are rated Aaa, in line with the ratings of the guarantee provider. Rating Drivers - Comprehensive, but still underexploited, retail network with sizeable deposit market shares in Austria - Elevated concentration and asset quality risks despite underlying improvements - Core earnings continue to suffer from low interest-rate environment and business re-alignment - Significantly improved capital ratios, but the quality of these metrics needs to be further developed - Strong access to stable retail deposits supports liquidity profile Rating Outlook The outlook on the standalone D BFSR is stable, reflecting our expectation that the bank's financial profile will improve from the current level, over time. Moreover, based on its current risk profile, we expect that the BFSR should be able to withstand some degree of earnings volatility and asset-quality pressure. Our outlook on the bank's debt and deposit ratings is also stable, while the outlook on 'grandfathered' debt ratings is negative, reflecting the outlook on the guarantee provider, the Republic of Austria. What Could Change the Rating - Up Upwards pressure on BAWAG's standalone BFSR could result from (1) successful implementation of the bank's strategy to focus on its core Austrian market and better exploitation of its retail footprint; (2) markedly stronger performance in client-facing businesses and reduced dependence on capital-market activities; and (3) further improving financial fundamentals. We highlight that a prerequisite for a potential upgrade in the bank's BFSR includes a significantly de-risked business profile accompanied by a continued improvement in risk culture and management as well as financial reporting and disclosure. In addition, we stress that an only moderate improvement in BAWAG's standalone BFSR is unlikely to result in a higher long-term rating, given that BAWAG already benefits from a three-notch uplift from its BCA of ba2.

3 What Could Change the Rating - Down Downwards pressure could be exerted on the bank's BFSR if (1) the bank's financial strength or franchise strength were to deteriorate; (2) the expansion of the domestic branch network fails to lead to a meaningful improvement in underlying revenues and earnings; (3) the bank's risk profile fails to improve or even weakens; and (4) BAWAG fails to continue building a high-quality capital buffer in-line with upcoming stricter capital requirements set by the Austrian regulator and the Basel committee on banking supervision (Basel III). BAWAG's long-term ratings could be downgraded if we were to lower our assessment of the very high probability of systemic support factored into the bank's long-term ratings. DETAILED RATING CONSIDERATIONS COMPREHENSIVE, BUT STILL UNDEREXPLOITED RETAIL NETWORK WITH SIZEABLE DEPOSIT MARKET SHARES IN AUSTRIA BAWAG - majority owned by US private-equity firm Cerberus (owning 51.8%) and US investor Golden Tree (since 2012, 39.5%) - is among the four largest banking institutions in Austria, providing universal banking services throughout the country, including retail banking, corporate banking and financial markets services. BAWAG benefits from a comprehensive retail banking franchise, serving more than 1.5 million retail customers, with market shares of more than 6% across key deposit products. Moreover, the cooperation agreement with Austrian Post (Oesterreichische Post AG, unrated), allowed the bank to develop a full common branch network throughout the country, with a target to increase its presence to around 500 branches from 150 previously (2012: 461). In addition, the bank continues to hold a dominant position in payment services in Austria as expressed through the postal savings bank privilege and the resulting strong links with the Republic of Austria. Nevertheless, we consider the bank's franchise value to be constrained by its still underexploited retail business. While the bank benefits from a significant share in domestic deposit gathering, this has not been accompanied by a similarly significant presence in retail lending activities and any related sustainable earnings increase. Instead, the bank's present key earnings drivers are commercial and - to an increasing extent - international lending and investment activities. We would thus expect BAWAG to turn its focus more actively towards expansion of its client reach through a variety of ancillary products, thus demonstrating its ability to effectively leverage its dominant position in the domestic retail market. Any positive reassessment of BAWAG's franchise value would require the bank to successfully improve its core retail profitability without compromising its risk profile, and, at the same time, keep winding down client-remote and / or capital-market activities. ELEVATED CONCENTRATION AND ASSET QUALITY RISKS IN SPITE OF UNDERLYING IMPROVEMENTS Our risk positioning assessment remains constrained by previous weaknesses, albeit we note the gradual improvements in risk-management practices and corporate governance. Furthermore, uncertainties regarding the expansion of BAWAG's international corporate and commercial real estate portfolios as well as the more recent investment in non-domestic collateralized loan obligations (CLOs) and peripheral euro area sovereigns constrain BAWAG's rating. BAWAG displayed total credit exposures of EUR38.2 billion as of end-june We note the bank's sizeable corporate lending book (EUR15.9 billion, including commercial real estate) and other high sector concentrations against banks (EUR7.9 billion) and the public sector (EUR7.4 billion). BAWAG's more granular exposures to the retail sector (EUR5.9 billion) remain relatively modest in spite of the significant re-build of its nationwide presence and, in our view, do not yet sufficiently mirror the bank's dedicated retail focus. As a result, our view of some indications of an improving risk positioning and culture will require further evidence of the bank's ability to fully establish a strong track record via full implementation of - and adherence to - the bank's retail-oriented strategy and more robust risk-management procedures. We note positively that BAWAG's impaired assets decreased to EUR1.1 billion or 4.9% of gross loans in 2012 (2011: EUR1.2 billion or 5.1% of gross loans). Nevertheless, these metrics still indicate a relatively weak asset quality, partly due to the bank's policy of not writing off long-standing problem loan positions. However, in our view, the bank has made adequate risk provisions. As BAWAG's international business continues to expand, driven by the bank's strategy of establishing

4 complimentary international (mainly corporate) exposures to its domestic activities, we consider the portfolio to be relatively unseasoned. As a result, the underwriting quality and related risk-adjusted pricing can only be assessed over time, constituting a significant source of uncertainty over BAWAG's future asset quality and composition. We further note that, during the first half of 2013, the bank increased its exposures to euro area sovereigns and structured credit products. We caution that these exposures - albeit significantly de-risked - still represent a significant proportion of the bank's Tier 1 capital. The reported exposure to euro area peripheral countries (i.e., banks, non-banks and sovereign) amounted to EUR1.5 billion on a net basis as of 30 June 2013, up from EUR1.1 billion at year-end 2012, reflecting predominantly an increase in volume of Spanish and Italian sovereign bonds as well as secured receivables. At the same time, the exposure to structured credit products increased to EUR924 million as of 30 June 2013 (2012: EUR610 million), including approximately EUR100 million in euro area peripheral countries. In an effort to reduce risk-weighted assets, the bank has restructured or sold higher-risk exposures such as CDOs and plans to completely exit its legacy structured credit book. However, BAWAG re-invested into higher-rated CLOs in Europe and the United Kingdom with longer-dated maturities. We consider these investments to be non-core and thus incongruent to BAWAG's overall strategy. We therefore believe that any more significant improvement in asset quality remains dependent on the performance of BAWAG's legacy and newly acquired assets and - more importantly - its success in re-positioning its overall lending portfolio without changing or adding to its risk appetite and non-core exposures. CORE EARNINGS CONTINUE TO SUFFER FROM LOW INTEREST-RATE ENVIRONMENT AND BUSINESS RE-ALIGNMENT Profitability has gradually recovered and stabilised from historically low levels. Nonetheless, BAWAG's profit and loss account continues to be influenced by related volatility in capital markets, most notably spreads, thereby significantly reducing visibility and stability of earnings. In addition, the profitability of the unseasoned international lending portfolio can only be assessed over time and, in our opinion, it is unclear whether risk-adjusted profitability levels can be maintained. Moreover, the modest earnings contribution of the strategically important retail division, which only posted a minor pre-tax profit in recent years, remains a constraining factor. During H1 2013, BAWAG suffered from a significant erosion of net interest income in light of the low interest-rate environment and the re-positioning (and thus slight downsizing) of its corporate loan book, reducing its core earnings by 13% year-over-year, to EUR357.6 million. Spread-related and one-time gains on financial assets as well as own debt and a slightly lower cost base, however, helped to stabilise BAWAG's reported net profit at EUR93.8 million in H (H1 2012: EUR 96.6 million). SIGNIFICANTLY IMPROVED CAPITAL RATIOS, BUT THE QUALITY OF THESE METRICS NEEDS TO BE FURTHER DEVELOPED With a Core Equity Tier 1 ratio of 12.3% at end-june 2013 (2012: 11.0%, 2011: 7.8%, Basel 2.5), BAWAG currently maintains an adequate capital cushion for its risk profile, in our view. The ratio benefitted from the adoption of the internal ratings-based approach (IRB) and further risk reduction during H1 2013, reducing riskweighted assets by approximately EUR2.6 billion since year-end 2012 (or 13%). Notwithstanding this effect, we continue to consider the bank's quality of capital to be weak, taking into account the upcoming Basel III regulatory regime. The introduction of stricter capital rules will thus lead to a significant erosion in the bank's capital ratios despite the credit positive EUR50 million payback of participation capital in June 2013 and a cash capital contribution of EUR200 million by BAWAG's owners in Our view reflects the bank's high proportion of hybrid elements in relation to overall capital (EUR500 million participation capital, EUR404 million minorities as well as EUR142 million preference shares). As a result, BAWAG needs to further improve the quality of its capital through internal capital generation and continued risk reduction. Over time, these improvements should facilitate further redemption of the participation capital that currently represents a significant burden to BAWAG (interest payment of EUR51.2 million in 2012; coupon step-up mechanism starting in 2014). Nevertheless, any further substantial repayment (exceeding 25%) of the government's participation capital is currently not included in our central scenario assumptions and would most likely require external capital raising. In addition, we note that any net charge for BAWAG resulting from a potentially unfavourable court ruling or

5 settlement agreement (City of Linz case) would be lower than the claim value due to credit value adjustments prior to termination of the original transaction. We therefore believe the risk of a significant loss and thus a sizeable reduction of BAWAG's capital ratios to be manageable. STRONG ACCESS TO STABLE RETAIL DEPOSITS SUPPORT LIQUIDITY PROFILE We consider BAWAG's liquidity profile to be adequate, given the granularity of its retail deposits and the progress made towards rebuilding its core deposits (H1 2013: EUR22 billion or 58% of total assets) and maintaining a loanto-deposit ratio of 97% as of June 2013 (2012: 101%). The bank's main funding sources are retail and, to a lesser extent, corporate deposits, which together account for most of its total funding requirements. We therefore believe that BAWAG will be able to maintain a balanced liquidity profile despite relatively high maturities in 2014 and We anticipate the maturities to be covered by existing cash, the continued reduction in BAWAG's balance sheet and thus funding needs as well as its large portfolio of on-balance sheet liquid unencumbered assets. Global Local Currency Deposit Rating (Joint Default Analysis) We assign GLC deposit ratings of Baa2/Prime-2 to BAWAG. This rating is supported by BAWAG's ba2 BCA and our assessment of a very high probability of systemic support built on the existing support measures from2006 and 2009 as well as the bank's sizeable national deposit market share and its importance to the country's payment system. Therefore, the GLC deposit rating is supported by Austria's Aaa local-currency deposit ceiling, resulting in a three-notch uplift from the ba2 BCA. Notching Considerations BAWAG's subordinated debt is rated Ba3 with a stable outlook, one notch below the adjusted BCA of ba2. The adjusted BCA excludes systemic support expectations. The non-cumulative preferred securities issued by BAWAG Capital Finance (Jersey) Ltd are rated B2(hyb) with a stable outlook, three notches below the adjusted BCA according to our guidelines for hybrid instruments. Foreign Currency Deposit Rating BAWAG's foreign currency deposit ratings are Baa2/Prime-2. Foreign Currency Debt Rating BAWAG's foreign currency debt ratings are Baa2/Prime-2. ABOUT MOODY'S BANK RATINGS Bank Financial Strength Rating Moody's Bank Financial Strength Ratings (BFSRs) represent Moody's opinion of a bank's intrinsic safety and soundness and, as such, exclude certain external credit risks and credit support elements that are addressed by Moody's Bank Deposit Ratings. BFSRs do not take into account the probability that the bank will receive such external support, nor do they address risks arising from sovereign actions that may interfere with a bank's ability to honour its domestic or foreign currency obligations. Factors considered in the assignment of BFSRs include bank-specific elements such as financial fundamentals, franchise value, and business and asset diversification. Although BFSRs exclude the external factors specified above, they do take into account other risk factors in the bank's operating environment, including the strength and prospective performance of the economy, as well as the structure and relative fragility of the financial system, and the quality of banking regulation and supervision. Global Local Currency Deposit Rating A deposit rating, as an opinion of relative credit risk, incorporates the BFSR as well as Moody's opinion of any external support. Specifically, Moody's Bank Deposit Ratings are opinions of a bank's ability to repay punctually its deposit obligations. As such, they are intended to incorporate those aspects of credit risk relevant to the prospective payment performance of rated banks with respect to deposit obligations, which includes: intrinsic financial strength, sovereign transfer risk (in the case of foreign currency deposit ratings), and both implicit and explicit external support elements. Moody's Bank Deposit Ratings do not take into account the benefit of deposit insurance schemes which make payments to depositors, but they do recognise the potential support from schemes that may provide assistance to banks directly.

6 According to Moody's joint default analysis (JDA) methodology, the global local currency deposit rating of a bank is determined by the incorporation of external elements of support into the bank's Baseline Risk Assessment. In calculating the Global Local Currency Deposit rating for a bank, the JDA methodology also factors in the rating of the support provider, in the form of the local currency deposit ceiling for a country, Moody's assessment of the probability of systemic support for the bank in the event of a stress situation and the degree of dependence between the issuer rating and the Local Currency Deposit Ceiling. National scale rating National scale ratings are intended primarily for use by domestic investors and are not comparable to Moody's globally applicable ratings; rather they address relative credit risk within a given country. A Aaa rating on Moody's National Scale indicates an issuer or issue with the strongest creditworthiness and the lowest likelihood of credit loss relative to other domestic issuers. National Scale Ratings, therefore, rank domestic issuers relative to each other and not relative to absolute default risks. National ratings isolate systemic risks; they do not address loss expectation associated with systemic events that could affect all issuers, even those that receive the highest ratings on the National Scale. Foreign Currency Deposit Rating Moody's ratings on foreign currency bank obligations derive from the bank's local currency rating for the same class of obligation. The implementation of JDA for banks can lead to high local currency ratings for certain banks, which could also produce high foreign currency ratings. Nevertheless, it should be noted that foreign currency deposit ratings are in all cases constrained by the country ceiling for foreign currency bank deposits. This may result in the assignment of a different, and typically lower, rating for the foreign currency deposits relative to the bank's rating for local currency obligations. Foreign Currency Debt Rating Foreign currency debt ratings are derived from the bank's local currency debt rating. In a similar way to foreign currency deposit ratings, foreign currency debt ratings may also be constrained by the country ceiling for foreign currency bonds and notes; however, in some cases the ratings on foreign currency debt obligations may be allowed to pierce the foreign currency ceiling. A particular mix of rating factors are taken into consideration in order to assess whether a foreign currency bond rating pierces the country ceiling. They include the issuer's global local currency rating, the foreign currency government bond rating, the country ceiling for bonds and the debt's eligibility to pierce that ceiling. About Moody's Bank Financial Strength Scorecard Moody's bank financial strength model (see scorecard below) is a strategic input in the assessment of the financial strength of a bank, used as a key tool by Moody's analysts to ensure consistency of approach across banks and regions. The model output and the individual scores are discussed in rating committees and may be adjusted up or down to reflect conditions specific to each rated entity. Rating Factors BAWAG P.S.K. Rating Factors [1] A B C D E Total Score Trend Qualitative Factors (50%) C- Factor: Franchise Value C- Neutral Market share and sustainability x Geographical diversification x Earnings stability x Earnings Diversification [2] Factor: Risk Positioning D Neutral Corporate Governance [2] x - Ownership and Organizational Complexity x - Key Man Risk

7 - Insider and Related-Party Risks Controls and Risk Management x - Risk Management x - Controls x Financial Reporting Transparency x - Global Comparability x - Frequency and Timeliness x - Quality of Financial Information x Credit Risk Concentration x - Borrower Concentration x - Industry Concentration x Liquidity Management x Market Risk Appetite x Factor: Operating Environment A- Neutral Economic Stability x Integrity and Corruption x Legal System x Financial Factors (50%) C- Factor: Profitability D Neutral PPI % Average RWA (Basel II) 1.45% Net Income % Average RWA (Basel II) 0.66% Factor: Liquidity C Neutral (Market Funds - Liquid Assets) % Total Assets 4.68% Liquidity Management x Factor: Capital Adequacy B+ Improving Tier 1 Ratio (%) (Basel II) 10.07% Tangible Common Equity % RWA (Basel II) 7.45% Factor: Efficiency C Neutral Cost / Income Ratio 64.33% Factor: Asset Quality D+ Neutral Problem Loans % Gross Loans 4.81% Problem Loans % (Equity + LLR) 35.53% Lowest Combined Financial Factor Score (15%) D+ Economic Insolvency Override Neutral Aggregate BFSR Score C- Aggregate BCA Score baa1/baa2 Assigned BFSR D Assigned BCA ba2 [1] - Where dashes are shown for a particular factor (or sub-factor), the score is based on non-public information. [2] - A blank score under Earnings Diversification or Corporate Governance indicates the risk is neutral Moody's Investors Service, Inc. and/or its licensors and affiliates (collectively, "MOODY'S"). All rights reserved. CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. ("MIS") AND ITS AFFILIATES ARE

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